The economics of Groupon

The dismal scoop on Groupon

A micro-economist assesses Groupon

ON OCTOBER 24th Groupon says it will start its “roadshow”. The social-media sensation, which offers online coupons for bargains at local shops and restaurants, is planning an initial public offering later this year. Valuations as high as $20 billion were until recently bandied around, but that now seems wildly optimistic. Groupon will lose $280m on revenues of $1.69 billion in 2011, predicts Benchmark, a consultancy. That is an ocean of red ink.

Groupon started with a nifty idea. Its website offered a “daily deal” whereby consumers could buy a product or service very cheaply if a minimum number of people signed up. People would nag their friends to come to the same bar or shop. The merchant would get new customers. Groupon would take a cut.

For merchants, this model has big advantages. They are advertised on Groupon's phenomenally popular website. This is especially useful for new businesses that no one has heard of.

Groupon helps merchants manage capacity, too. For example, a restaurant might sell vouchers that are redeemable only on Tuesdays, thus filling tables on a quiet night. Or a Pilates studio might use vouchers to manage class sizes. Once a client has paid for the voucher, the studio collects the fee even if she is hung-over and doesn't turn up.

Groupon also allows merchants to charge different people different prices for the same product. A student might buy theatre tickets on Groupon for half price. A businessman with no time to shop around online might buy the same tickets for full price. Without Groupon, it is harder for the theatre to find out what people are willing to pay. It could charge both punters full price, in which case the student may stay at home. Or it could charge both the lower price, in which case it makes less money.

Groupon created a new market. This is a boon to consumers, but confers no lasting “first-mover” advantage on Groupon. Its business model is unpatentable and simple to replicate, so there are already more than 20 copycats.

Groupon aspires to be global, but the markets it serves are intensely local. Internet selling is best suited to “experience goods”. These are goods and services the quality of which you cannot judge until you experience them, such as haircuts and Thai meals, so there is no advantage in having a bricks-and-mortar shop for people to browse in. (In North America 83% of Groupon's deals fall into this category.) The trouble with experience goods is that generally you cannot separate manufacture from delivery: you cannot cook a meal in Guangzhou and eat it in New York.

So for Groupon, each city is a separate market. (Big ones, such as London, are subdivided into regions.) In each neighbourhood, it must vie with copycats to sign up merchants. Its marketing costs are expected to be a painful $958m this year. This is why it loses money.

A final woe: the Groupon model is open to abuse. Nicole Peters, an avid online shopper, describes how she bought a massage via one of Groupon's rivals. The day before the appointment, the massage firm e-mailed her to say it had gone bust. Ms Peters also bought a voucher for several pairs of men's underpants. When she logged onto the supplier's website, there were only huge pairs or bright pink ones available. She says she will never shop this way again. Groupon's webpage includes a guide to avoiding arguments with merchants, which suggests such tiffs are common.

In short, Groupon is still the king of online discounts. But with so many pretenders around, it may be unwise to pay a premium for its shares. On October 19th the firm was reportedly considering scaling back its IPO.